Author

Daniel BustamanteInstructor | Portfolio Management & Advanced Options

Do Low Risk Trades Actually Exist? And if So, How often Do they Occur?

One of the biggest misconceptions for investors is that you need to take on large amounts of risks to make gains. This simply is not true, though, it depends on how you perceive markets and risk I suppose. It usually brings on a conversation about 'diversification' in one's portfolio which by minute 2-3 in people's eyes tend to glaze over with confusion. So we ask the question: Do low risk trades occur and if so how often do they come about?

The answer, as we'll show in this article below, is yes. The frequency? More than you think, just not in the terms that most of us are used to doing: Buying a stock when it's 'cheap' and holding it for 3 years "because at $3 a share how much lower can it really go?" - The answer, much lower, even zero. So let's break down how to find low-risk and high-reward trades with a review of a $2,285 gain on Priceline below.

Price Zones Matter​

The answer really is two fold - One, it requires market timing/entry techniques that allow you to enter a trade when the risk is 'minimal' (Yes, if this makes no sense it will) and Second, it requires an understanding of deploying the right strategy for that trade. Most people will denounce picking a market turn or timing entries and that's fine, but usually, they're the folks who have never truly sat down and studied a price chart and market mechanics.

The first thing students in Core Foundations of Trading learn when putting on a trade is to find where the potential price entry area is (Price is an Area not an exact number) and then second, where three price targets are. In the chart and trade below we have an example of a low-risk entry on Priceline, two in fact, with the second test being the A+ entry. ​

First, let's focus on the first note - Macro support area. Most investors fail to understand the concepts of time frames, larger time frames matter more than smaller time frames. The support pivot at $1600 was the start of a reversal from the October sell off. From there, we rallied, retraced and created the first higher low support area. This was entry one. Next we have another higher low at $1725 and a +$100 rally in 2 trading days, this entry, is the prime "A+" entry.

In this example there were a few ways to trade this. I elected for a long directional call option that cost $2.15 netting a healthy profit of $2,285 in two days.

Now as I mentioned above, once you find an optimal low risk to reward entry on the chart you can then choose the optimal product/strategy to execute on that idea. In this case, it was a directional call option, with a max risk of $215.

Therefore, we not only minimized our entry risk (on the chart) but also the trade risk (through a fixed cost) through a call option. This is as good as trading gets from a risk/reward standpoint.

Conclusion

Speculation in asset classes is just that, speculation. However, we can provide ourselves with an edge to minimize risk and unlock large potential upside trades using the correct tools. The one question I found myself asking students at our free and Trading 101 classes in 2017 was: "On the last stock you bought, what is your exit price and stop?" The answer, usually was, the simply didn't know.

As investors our number one job is to manage risk at the end of the day, not to have opinions on why a stock should go up or down, so ask yourself before you take the next trade whether or not it's low risk and high reward scenario.

I hope this helps and here's to a profitable and educational 2018 for everyone.

Trading Futures, Options on Futures, and retail off-exchange foreign currency transactions involves substantial risk of loss and is not suitable for all investors. Past Performance is not indicative of future results. With regard to any testimonials posted on this site, please note that any references to performance depends on each individual’s unique skills, time commitment effort and capital. Individuals sharing their results have not been compensated and any results have not been independently verified. Results may not be typical and individual results may vary.﻿